No Solace for the Euro Just Yet

The US dollar continues its rally with the euro the major culprit of the market’s negativity as risks of contagion appear to be spreading to the core.  Despite more positive economic data from Germany (this time favorable unemployment numbers), the euro continues to suffer, breaking the 200-day moving average along with the 50% retracement level.  The negative euro news has also found its way into positioning with CFTC reports suggesting that the market is now net seller of euros. Meanwhile, the risk-off sentiment, coupled with a weak consumer confidence report, continues to weigh on sterling with the price action reaching a low of $1.550.  And despite the raft of economic data, highlighting the weakness of the Japanese economy, the yen is one of the few outperformers versus the dollar as risk aversion stokes demand for safe haven currencies. Elsewhere, China tightening concerns and euro-zone contagion risks continue to weigh on the antipodean currencies with the kiwi and Australian dollar both experiencing selling pressure.

Global equity markets are mixed again with the fears of a China hike, coupled with euro-zone contagion risk, dragging down sentiment.  For one, Asian stocks are markedly lower with MSCI Asia index down -0.7%.  The Nikkei is down nearly -2%, led by losses in consumers.  At the same time the Shanghai Composite is down -1.6% with large losses in health care. And yet In Europe stocks were higher with the Euro Stoxx 600 up 0.5% led by a 0.8% gain in materials.  Meanwhile, the FTSE and Dax are both up 0.3% and 0.8% respectively, led by gains materials and consumer goods.  Furthermore, Irish financials are up nearly 3% and short-term dollar demand may be supported as ABB Ltd, the Swiss maker of factory robots, agreed to buy Baldor Electric for about $3.1bln in cash.

European sovereign bonds yields continued to increase as this weekend’s debt agreement for Ireland and the establishment of a permanent rescue mechanism failed to restore confidence.  Namely, 10-year Greek yields are up 15bp followed by 6bp increase in the new target Belgium and 3.5bp increase in Italian yields.  In a bond auction today Belgium raised a total of €2.795bln, at the upper end of the €2.8bln intended range via its offering of 106/169 day T-bills.  This was better than yesterday’s dismal results but nonetheless the Belgium 10-year spread to Bunds is 10bp wider on the day to 125bp.  Meanwhile, 10-year German yields are down 7bp with the 10-year US Treasury down 4bp, increasing the US’s yield advantage and further supporting dollar longs.

Currency Markets

There is one major driver in capital markets: the widening crisis in Europe.   Month end demand for euros has been more than offset by concern that Europe is experiencing a systemic and existential challenge.  Pressure is evident outside of the periphery, which has up until now been the main focus.  Spanish, Italian and Belgian bonds are getting hit harder than Portugal and Greek bonds in recent sessions.  Over the past five days, the 10-year Italian bond yield is up 40bp.  The similar yield in Spain is up 56bp and up 38bp in Belgium.  The 10-year yields in Portugal are flat and off 23bp in Greece.  The ECB did step up its sovereign bond purchases last week to the most in 2-months.   But the contagion risk is palpable and spreading to the core of Europe.  The Irish package, of course, failed to dispel misgivings and the fact that Ireland itself coming up with 20% of its own aid package seems to deny officials any shock and awe potential.  Moreover, the interest rate average of 5.8% does not appear very concessionary, though it is lower than the crisis induced levels. 

In addition, officials have failed to get ahead of the curve of market expectations in preemptive funding of Portugal, if not Spain (where the old saw of a stitch in time saves nine comes to mind).  Perhaps the biggest problem is lack of appreciation of the significance of confidence in the functioning of the modern credit economy.  European officials have squandered this confidence and like toothpaste coming out of a tube, it is difficult to put in back in.  Spain, for example, we are told, is not a problem because the government debt to GDP is a relatively mild 63% of GDP.  Yet the total debt is closer to 270% of GDP.  Meanwhile the IMF estimates the gross financing needs for 2011 will be €226bln (~21% of GDP), Spanish banks appear to have to roll over the same amount.  What is the ECB to do?  It meets on Thursday, December 2.  It had been expected to announce plans to continue to unwind its extraordinary liquidity provisions in the new year.  Yet if it were to follow through with this, it could exacerbate the current crisis withdrawing liquidity when private banks and sovereigns need it most.  However, this is to simply move to the other horn of the policy dilemma.  Its unlimited provision of liquidity for three-months at 1% may be supporting insolvent institutions and keeps the paper chase going without addressing it.

South Korean industrial production rose less than expected in October, damping concerns that growth is fueling inflation and suggesting the Bank of Korea may remain on hold next week. Output increased 13.5% in October from a year earlier, compared with forecasts for a 15.1% gain. From a month earlier, production fell 4.2%, the third straight drop. The BOK meets next week after hiking by a quarter point earlier this month to 2.5%, and after a quarter point rise in July. The period in between saw the bank leave rates unchanged as it weighed concerns about slowing global growth with rising domestic inflation – CPI broke through the 4% mark in October. The leading index also came in weaker, rising 3.4% in October vs 4.9% growth in September.

Upcoming Economic Releases

At 9:00 EST / 13:00 GMT US reports September’s S&P/Case-Shiller Housing index.  The m/m 20 city index is expected to fall to -0.4% from -0.2% in August.  Next, the US reports November’s PMI which is expected to dip to 59.9 from 60.6 in October followed by November’s consumer confidence figures and the NAPM-Milwaukee. At the same time Canada reports its month GDP clip which is expected to 0.1% from 0.3% in August with 3Q GDP expected to fall to 1.4% from 2.0%.  Meanwhile, Mexico reports its budget balance for the month of October at 1:30 PM / 17:30 GMT.  Events: Fed’s Bernanke and Kocherlakota (FOMC non-voter) while the house subcommittee hearing on the Fed has been postponed. 

  1. Kikezurita says

    Hi Edward, there are some key factors to disregard (from a fundamental analysis point of view) a possible bailout of Spain:
    1) As you mentioned goverment debt accounts for a 63% to GDP (is more a private problem)
    2) Spanish banking system is concentrated around BBVA and Santander, which are very diversified, international and in a financially healthy situation/position.
    3) The reestructuring and recapitalisation process in the several unhealthy Savings Banks through the Spanish TARP (FROB) will hopefully come to a sucessful end soon (allowing to start providing liquidity back to SMEs in a Business-As-Usual basis).
    4) Major Spanish multinational firms (as mentioned regarding the major banks) are very diversified internationally and in a healthy financial position.

    These among others are fundamental reasons why Spain should not need to be bailed out.
    Moreover, once there is a definitive bailout plan for Portugal (Spanish banks have a significant exposure to Portuguese debt) and ECB back-up on Thursday many doubts about Spain should come to an end.

  2. Kikezurita says

    Sorry for the mistake, the previous comment was adressed to the author of this post/article (Marc Chandler)

Comments are closed.

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